First Small Multi Family... Help please!

[Jake Denning]

My partner and I are currently working on a triplex but I am having some difficulties justifying everything because of the SOW. The Triplex is in pretty rough shape, there are two units which are stacked (upstairs and downstairs) as well as a separate unit. The two stacked units currently one is a 3/2 and the other can be turned into a 3/2, the separate building would be a 1/1. When this property was built it was just a duplex but they converted one of the units into two which are now stacked and the foundation was not meant for all the weight so the slab is sinking into the ground. I got a bid from our contractor who we know knows his stuff and all in all we would have to spend about 155k to get everything updated, cosmetically, structurally and save the property. It is no small project for us anyways. Only one unit is being leased out right now and it is the 3/2 that is upstairs for $535/m which is severely under market, we estimate the market rent to be about $1050/m each 3/2 and $750 for the 1/1 but the rest have to be finished out to be rentable.

The place we are concerned with is how the property will appraise in the future so that we can get ALL our money back out and turn it into a BRRRR. It is in a blue-collar more rural area on the outskirts of Houston. There are not a ton of comparable properties for us or a future appraiser to look at. We would estimate to be all-in the purchase price of 80k and rehab of 155k to 235k when it is said and done plus our closing costs, maybe around 255k. The property would need to appraise for around 330k to get most of our money back and have very little money left in the deal at an 80% refi, Problem is that we don't have much in the way of comps to base it off of. There was a 4-plex that is listed for 320k but they had no appraisal and were just basing it off the rents.

If we had everything up to date and fully rented we would have approximately $2850 gross rents, not quite the 1% rule we would like, Does anyone know if an appraiser would take rents into consideration if there are not alot of comps for small-multi? Or what is your take on the deal?

The owner also offered to owner finance the deal for a $400/m pmt for 2 years but at a 3% interest rate and 5% prepayment penalty, and a 20k down payment. So I know we could cover our costs no problem, I guess I am having trouble foreseeing what will be the end of this once we are all in, as we will have rehab loans to repay and principal balance to finish paying at the end of the 2 years...

Thanks in advance to anyone who takes the time to read this one...

[Richie Thomas]

Hey @Jake Denning, I'm only an aspiring investor (not an actual one, yet).  So take what I say with a grain of salt.

The first thought that occurred to me is to double-triple-check that the property's conversion from a duplex to a triplex was approved by city or county inspectors, and recorded with the recorder's office.  If the foundation is literally sinking into the ground due to the weight of the upper unit, it seems to me like there's a greater-than-zero chance that some un-permitted work took place.  If so, any code violations become your problem once you purchase the property.  And that problem gets worse if you accidentally rent to a professional tenant.  One way these people can cause problems for landlords is by calling the building inspectors (see this guy's story for an example).  If the work wasn't done to code, you could end up paying repair costs, building code fines, and suffering loss of rental income, since some jurisdictions don't allow you to collect rent until the building's defects are cured.  The good news is that, if you find out before you purchase that the work wasn't up-to-code or wasn't recorded, you could opt to use this information as leverage to talk the seller down on price.

The other thing I thought of when reading your post was that an appraiser may want to see the new rent values stabilized before factoring them into the appraisal.  My understanding is that this means you need to achieve a certain percentage of occupancy for a certain length of time (i.e. 80% occupancy for at least a year, although those are just hypothetical numbers).  I believe this would normally apply to commercial properties, which in this case would mean those with 5 or more units.  But a 4-unit is right on the cusp of that.  And in an area with few comps like the one you described, my guess is there's more ambiguity (and possibly more leeway as well) in the valuation process.  If you want the property to be appraised according to its ability to produce income, they might decide to use their regular criteria for income-producing properties.  Hopefully the bank's appraiser would be cooperative and use whatever criteria will result in a higher loan amount (which seems like it would be a win-win for you and the bank).

Of course, that doesn't mean you won't ever get your cash out at the higher appraisal value, you just might have to wait awhile before you can refi for the maximum amount.  The good news is that, in the meantime, you can still charge those higher rent amounts and get your cash flow going.